Four at Four: A Familiar, Comforting Sort of Lousiness

By David Gaffen

The extended Santa Claus rally was cut off late last week and has run into a more alarming reality this week (other than Santa not being real): The banks aren’t coming along for the ride. “There’s just a lot of worry about financial companies, that they might have to raise additional capital — nobody really wants to buy aggressively here,” says Paul Brigandi, vice president of trading at Direxion Funds. Losses from Deutsche Bank, worries about Citigroup, and generalized pressure contributed to the 6% drop in the Philadelphia Stock Exchange/KBW Bank Index Wednesday, and Citigroup led the way with a 23% decline to close at $4.53 a share, its lowest close since Nov. 21, 2008. “Even average bear market rallies get adequate financial sector participation and real bottoms definitely need financials to be outperforming, not underperforming,” writes Smita Sadana on Minyanville.com. Adding to the malaise, retail sales came out worse than anticipated, and the Federal Reserve’s anecdotal assessment of the economic situation suggests an ongoing deterioration in the economic landscape headed into 2009, with job cuts across the country and weak consumer demand. It is a bit of a concern that the worry is, once again, centered on the financial companies, and the silver lining appears to be that credit spreads and short-term lending rates are behaving themselves a bit. Volatility has spiked, with the Chicago Board Options Exchange volatility index (the VIX) rising 13.6% to close at 49.14, but Randy Frederick, head of derivatives at Charles Schwab & Co., says the activity is “more orderly and more in line with where it probably should be, relative to the movement on the S&P 500.” So in other words, it’s still bad, but familiar bad. Take of that what you will.

The devolution of Citigroup into a diminished version of the colossus that once sat astride the pillars of the financial landscape (picture that if you can) has produced more than a triumphant feeling of those who never thought the financial supermarket was a viable model to begin with. Citigroup, as it turns out, was held together largely by rubber bands and the forceful personality of its former kingmaker, Sanford Weill, and without him at the helm, the reality of this technological terror has become apparent. That’s why there’s a bit of irony in that the remaining financial giants have devoured other disparate firms, creating their own hydra, thus concentrating the risks in larger masses. “I find it interesting that so many people are cheering the death of the financial supermarket business model when in fact those left standing are going to take the notion of too big to fail to another level,” writes Charles Payne, president of Wall Street Strategies. He notes the monster created by Bank of America’s purchases of Countrywide Financial and Merrill Lynch; the J.P. Morgan Chase operation, which now includes Bear Stearns and Washington Mutual, and Wells Fargo, which at least purchased another similar commercial bank in Wachovia. It may be that Citigroup was undone by ineffective management and over-leverage, and that these other brachiosaurii will remain strong. But outside of the oil industry, mega-merged giants, like Blind Faith and other supergroups, tend to cannibalize themselves over time.

By now the expectations for a surprise from the European Central Bank have diminished, even in the face of lousy economic data. Jean-Claude Trichet, head of the ECB, and firmly established as the Goldfinger of the markets, is likely to resist larger-than-anticipated interest-rate cuts, so when the committee meets during European market hours Thursday, the hope is for a reduction in the target interest rate by a half-percentage point to 2%, which would be an all-time low for the bank. The expectations for such a move were heightened after a report saying the German economy contracted sharply in the last quarter of 2008, and euro zone industrial output dropped in November. Still, there’s always the possibility that the ECB will surprise on the wrong side, by only reducing rates by a quarter of a point. Kathy Lien, director of currency research at GFT, says the odds are better for this occurring than a reduction of 0.75 percentage point, and if that’s what transpires, the euro could see a sharp rally, motivated by those holding short euro positions. “I think what we’re seeing is the price indication shows everyone on the same side of the trade so therefore, the only surprise would be a smaller rate cut given the comments and tone of the ECB until now,” she says.

Seeing Nortel Networks file for bankruptcy protection, one recalls that the company once was the Canadian stock market. In the height of the Internet/technology bubble of the late 1990s, the company accounted for more than a third of the total valuation of all of the companies listed on the Toronto Stock Exchange, with a market capitalization of nearly $250 billion. As Nortel went, the TSX went as well. The Canadian stock market has moved on from those days, slowly regaining losses from some years ago while Nortel circled the drain, and as Mark Sue, analyst at RBC Capital Markets pointed out, the company was stuck in limbo while the rest of the markets moved forward. “It was quite amazing how it could go from hero to zero quite rapidly,” he says. The company was mired in accounting scandals, and the company was unable to turn itself around before its debt burden got the better of it (sound familiar?). Ultimately, the company’s equipment assets will fetch a decent price, but nobody wanted to take on that debt. “If you think about the entire decade, the company never put any money away in the bank,” Mr. Sue says.

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